2007 All Over Again, Part 5: Banking Crisis Imminent

Our good friend Michael Pollaro just sent a chart from the St. Louis Fed that
shows the US drifting back into yet another banking crisis.

The green line tracks fluctuations in the US yield curve, defined as the difference
in yield between 10-year and 2-year Treasuries. When the yield curve is steeply
positive, banks are able to borrow short at low rates and lend long at higher
rates, earning a nice return and in the process driving economic growth.
When the yield curve flattens the opposite occurs, with banks unable to make
money and becoming reluctant to lend. So a flattening yield curve implies
a slowing economy. Note the similarity between the past few years' spread
contraction and the one that began in 2004 and culminated in the Great Recession.

Now check out the red and blue lines representing different measures of credit
quality. The lower they are, the fewer loans are in various categories of "non-performance," and
vice versa. What's happening now is similar to the spike in bad loans that
started in 2005.

The implication: Despite the headline numbers (like Friday's
largely-fictitious jobs report) that imply a stable, modest expansion,
under the surface the financial system -- composed of business loans,
bank profits, etc. -- is deteriorating fast.

And since interest rates have fallen rather than risen post-Brexit, causing
yield curves around the world to flatten further, it's safe to say that these
trends are accelerating.

That would explain why so many iconic money managers and speculators have
turned publicly bearish recently. The latest is Jeremy Grantham of
Boston-based hedge fund GMO. Here's an excerpt from a MarketWatch article
on his firm's current stance:

You need a portfolio of at least $5 million to get in the door as a client
at Boston-based money management firm GMO.

And with some reason. The firm is famous for predicting the last two financial
crashes ahead of time, and firm chairman Jeremy Grantham is a legendary
figure on Wall Street. His quarterly letters are required reading by
anyone managing other people's money.

GMO is usually seen as too bearish, but in an industry that is generally
far too bullish that's no bad thing. And often forgotten is that the
firm has made some terrific contrarian buy recommendations too -- such
as emerging markets and value stocks at the start of the last decade,
and of stocks generally in the wake of the 2008-09 crash.

But for those of us who don't have $5 million or $10 million knocking
around, what's GMO's best advice at the moment? To find out, I spoke
to Matt Kadnar, a member of the firm's asset allocation committee. Here's
what he said about how GMO perceives the current global investing environment:

1. The overall investment outlook is really, really dismal. "There is
no asset out there that is cheap," Kadnar says. None.

2. The outlook for U.S. stocks is terrible. GMO's central forecast --
which is a directional estimate more than a precise prediction -- warns
that U.S. large- and small-cap stock indices are now both so overpriced
compared to history that they will probably lose value, compared to inflation,
over the next seven or so years.

3. In the wake of the emerging markets slump and now Brexit, investors
are becoming almost as dangerously fixated on U.S. stocks as they were
(disastrously) in 2000, according to GMO. Kadnar says that once again,
clients are starting to ask why anyone needs to own anything other than
the S&P 500.

4. Investors also are likely to end up losing -- after inflation -- over
the next seven years or so on U.S. bonds, cash, and small-cap international
stocks, GMO's current central forecast predicts. The firm also sees minuscule
post-inflation, or "real" returns, on both international large-cap stocks
and emerging-market bonds.

John Rubino edits DollarCollapse.com and has authored or co-authored five
books, including The Money Bubble: What To Do Before It Pops, Clean
Money: Picking Winners in the Green Tech Boom, The Collapse of the Dollar
and How to Profit From It, and How to Profit from the Coming Real Estate
Bust. After earning a Finance MBA from New York University, he spent the
1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst.
During the 1990s he was a featured columnist with TheStreet.com and a frequent
contributor to Individual Investor, Online Investor, and Consumers Digest,
among many other publications. He now writes for CFA Magazine.